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Newman's Renewed Focus on the Confidential Nature of Information Shared With Tippees

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INSIDER TRADING

By Julie M. Riewe and Jarrod L. Schaeffer

Julie M. Riewe is a partner and Jarrod L. Schaeffer is an associate at Debevoise &
Plimpton LLP.

While numerous commentators and practitioners have discussed the impact of
Salman v. United States, 558 U.S. ___ (2016), on insider trading law –
particularly in the Second Circuit, where open questions remain about the viability
and continuing effect of that court’s decision in
United States v. Newman, 773 F.3d 438 (2d Cir. 2014)
– most have focused largely on the “personal benefit” requirement for insider trading
liability. Although the personal benefit requirement is certainly at the core of both
cases, there is far more to
Newman that survives the Supreme Court’s decision. This article focuses on a less discussed
yet important aspect of the
Newman opinion:
the Second Circuit’s unusual treatment of material non-public information, which may
mark a departure from past approaches and have significant implications for future
enforcement actions.

On December 6, 2016, the United States Supreme Court decided
Salman, which affirmed an insider trading conviction out of the Ninth Circuit and pared
back the Second Circuit’s interpretation of the personal benefit requirement announced
in
Newman –
at least as to tippers providing information to family members. Hailed as a victory
for prosecutors, the Court in
Salman rejected as inconsistent with its prior decision in
Dirks v. S.E.C., 463 U.S. 646 (1983), a requirement that the Government prove tippers “receive[d]
something of a ‘pecuniary or similarly valuable nature’ in exchange for a gift to
family or friends,”
Salman, 558 U.S. at ___ (quoting
Newman, 773 F.3d at 452), before a jury could infer that a tipper received a “personal benefit”
for disclosing inside information.
Id. Left undisturbed by
Salman was
Newman’s additional holding that the Government must prove that the tippee knew the tipper
had received a personal benefit.
Id. at __ n.1
(citing
Newman, 773 F.3d at 453–54).

Another aspect of
Newman that remains good law following the Court’s decision in
Salman may temper the scope of the Government’s victory. While analyzing whether the tippee
defendants in
Newman, Todd Newman and Anthony Chiasson, knew that tipping insiders had received a personal
benefit, the Second Circuit opined that “the Government presented absolutely no .
. . evidence that Newman and Chiasson knew that they were trading on information obtained
from insiders,” 773 F.3d at 453, and rejected the Government’s contention that “the
specificity, timing, and frequency of the updates provided to Newman and Chiasson
about Dell and NVIDIA were so ‘overwhelmingly suspicious’
that they warranted various material inferences that could support a guilty verdict.”
Id. at 454. In doing so, the court recounted several instances in the record that demonstrated
insiders routinely shared confidential information prior to the information being
released to the general public.
Id. This close parsing signals the Second Circuit’s intent to take a closer look at the
nature of information actually disclosed by insiders in such cases – an inquiry that
could complicate future enforcement actions involving downstream tippees.

Background

Some general background may be helpful to frame this discussion. Confidential information
underlying allegedly illicit trades is usually called “material nonpublic information.”
At bottom, this is information available only to an insider by virtue of his or her
status as an insider, which affords an unfair trading advantage. Notably, unlike other
countries with major securities exchanges, the United States does not have a statute
that explicitly bars insider trading. Rather, under federal law the insider trading
prohibition stems from a duty not to abuse a fiduciary relationship by trading on,
or tipping, material nonpublic information.
Dirks, 463 U.S. at 659–60. A tippee acquires a duty not to trade on material nonpublic
information only when a tipper has breached a fiduciary duty by disclosing the information
in exchange for a personal benefit and the tippee knew
(or, in a civil matter, should have known) that such a breach had occurred.
See Salman, 558 U.S. at ___ (citing
Dirks, 463 U.S. at 662);
Dirks, 463 U.S. at 660–62. In the context of the classical theory of insider trading liability,
“the defendant breaches a duty to, and takes advantage of, the shareholders of [a]
corporation,”
Salman, 558 U.S. at ___ n.2 (quoting
United States v. O’Hagan, 521 U.S. 642, 651–652 (1997))
(internal alterations omitted), while “the misappropriation theory premises liability
on a fiduciary-turned-trader’s deception of those who entrusted him [or her] with
access to confidential information.”
O’Hagan, 521 U.S. at 652. The Supreme Court has made clear that “[n]ot to require such a
fiduciary relationship”
in insider trading cases “would ‘depart radically from the established doctrine that
duty arises from a specific relationship
. . . and would amount to ‘recognizing a general duty between all participants in
market transactions to forgo actions based on material, nonpublic information.’”
Dirks, 463 U.S. at 654–55 (quoting
Chiarella v. United States, 445 U.S. 222, 231 (1980)) (internal alterations omitted).

This brings us to
Newman. Neither Newman nor Chiasson (the alleged tippees)
knew the source of the information they received, and the Second Circuit concluded
that no reasonable jury could have inferred that Newman or Chiasson knew – or deliberately
avoided knowing – that the information was the kind of material nonpublic information
that can form the basis of insider trading liability. While there is no bright-line
rule specifying what kind of information is considered confidential,
see, e.g., Robert A. Prentice,
The Internet and Its Challenges for the Future of Insider Trading Regulations, 12 Harv. J.L. & Tech. 263 (1999) (“There is no clear rule regarding when information
leaves behind its secret status and enters the public domain.”), courts generally
recognize that information is freely available only when it “ha[s] been effectively
disclosed in a manner sufficient to [e]nsure its availability to the investing public,”
SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 854 (2d Cir. 1968). Historically, this has been interpreted as some
“formal announcement to the entire financial news media” or an “official release known
to the media,”
id., though what constitutes a manner sufficient to make information available to the
investing public has become more complicated with the advent of the Internet.
See generally Prentice,
supra note 12, at 279 (“[T]he Internet and other new technologies have further roiled these
murky waters. These technologies create new means of making disclosures and thereby
create new situations where it is unclear whether the information has been made ‘public.’”).
Alternatively, information may be freely available when it is “fully impounded into
the price of [a] particular stock.”
United States v. Libera, 989 F.2d 596, 601 (2d Cir. 1993). This understanding draws on the efficient market
hypothesis and concludes that information reflected in a stock’s price should not
serve as the basis for insider trading liability because “[o]nce the information is
fully impounded in [the] price, such information can no longer be misused by trading
because no further profit can be made.”
Id. The information ultimately relayed to Newman and Chiasson hardly satisfied either
standard. After all, it concerned internal corporate earnings data and was shared
by company insiders with a select group of industry analysts in advance of any official
announcement.

A Closer Look

So why did the Second Circuit conclude that no reasonable jury could have inferred
Newman or Chiasson knew they were illegally trading on inside information, even though
the information they received at first blush appears to be material and nonpublic?
Although the information shared with Newman or Chiasson was confidential corporate
earnings data that had not been released, the court concluded that the record showed
such information was “of a nature regularly and accurately predicted by analyst modeling,”
Newman, 773 F.3d at 455, or could have been revealed through sanctioned corporate channels
without violating any fiduciary duty. As the Second Circuit recognized, “analysts
at hedge funds routinely estimate metrics such as revenue, gross margin, operating
margin, and earnings per share through legitimate financial modeling using publicly
available information and educated assumptions about industry and company trends,”
and use information “solicited
. . . from companies in order to check assumptions in their models in advance of earnings
announcements.”
Id. at 454. And the court further noted that the record in
Newman demonstrated that “NVIDIA and Dell’s investor relations personnel routinely leaked
earnings data in advance of quarterly earnings.”
Id. (internal quotation marks omitted). Given the routine flow of otherwise confidential
information in this manner, the court was unconvinced that Newman and Chiasson knew,
or consciously avoided knowing, that the information on which they traded originated
with corporate insiders, much less in breach of any insider’s fiduciary duty.

Newman thus signals that the Second Circuit intends to scrutinize carefully the confidential
label applied to information disclosed by insiders when evaluating whether such disclosures
really amount to breaches of fiduciary duties – particularly in insider trading cases
involving “remote tippees many levels removed from corporate insiders.”
Id. at 448. This more rigorous focus on what rises to the level of a breach sufficient
to trigger liability may be motivated by practical realities in today’s financial
sector, where widespread industry practices can result in the unequal dissemination
(while Regulation FD in theory limits companies’ selective disclosure of material
nonpublic information,
see 17 C.F.R. pt. 243, as a practical matter companies regularly speak to shareholders
and analysts) of possibly material information and industry participants often have
better access to corporate information than members of the general public. Such an
approach also finds support in
Dirks, where the Supreme Court rejected “the idea that the antifraud provisions [of the
securities laws] require equal information among all traders,” precisely because “[i]mposing
a duty to disclose or abstain solely because a person knowingly receives material
nonpublic information from an insider and trades on it could have an inhibiting influence
on the role of market analysts, which the SEC itself recognizes is necessary to the
preservation of a healthy market.” 463 U.S. at 657–58. By looking to the nature of
and existing disclosure practices regarding inside information,
Newman portends a closer inquiry that challenges assumptions about insiders’ confidentiality
obligations and hews more closely to the Supreme Court’s teachings that tippee liability
can flow only from a known breach of fiduciary duty.

Conclusion

So what does this mean for the industry and the bar? While distilling a clear rule
from
Newman will require further elucidation in future cases, the Second Circuit’s renewed focus
on current disclosure practices with respect to inside information may suggest that
industry participants and attorneys should scrutinize closely the nature of any information
allegedly disclosed in insider trading cases. In particular, industry participants
should also review how they treat confidential information, asking whether protections
accorded to such information demonstrates that disclosure is restricted not just in
theory, but also in practice.

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